corporate environmental accounting and...

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Chapter Chapter Chapter Chapter 7777

Corporate Environmental Accounting

And Reporting

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IN THIS CHAPTER

7.1 INTRODUCTION

7.2 SCOPE AND METHODOLOGY

7.3 CONCEPT OF ENVIRONMENT

7.3.1 ENVIRONMENT – A BIG CHALLENGE TO BUSINESS

7.4 ENVIRONMENTAL ACCOUNTING 7.4.1 COMPREHENSIVENESS OF FINANCIAL ACCOUNTING

FRAMEWORK 7.4.2 ADOPTION OF ENVIRONMENTAL ACCOUNTING

SYSTEM 7.4.3 ENVIRONMENTAL COSTS 7.4.4 IDENTIFICATION OF ENVIRONMENTAL COSTS 7.4.5 TREATMENT OF ENVIRONMENTAL COSTS IN BOOKS

OF ACCOUNTS 7.4.6 RECOGNITION OF ENVIRONMENTAL BENEFITS 7.4.7 SOCIAL/EXTERNAL COSTS 7.4.8 ENVIRONMENTAL LIABILITIES

7.5 ENVIRONMENTAL REPORTING

7.5.1 GENERAL ISSUES 7.5.2 PLACE AND TYPE OF ENVIRONMENTAL DISCLOSURES 7.5.3 QUALITATIVE CHARACTERISTICS OF ENVIRONMENTAL

INFORMATION 7.5.4 USERS OF ENVIRONMENTAL INFORMATION

7.6 ENVIRONMENTAL AUDIT

7.6.1 NEED FOR AUDIT OF ENVIRONMENTAL INFORMATION

7.6.2 PREPARATION AND AUDIT OF ENVIRONMENTAL STATEMENTS BY SAMPLE COMPANIES

7.6.3 ENVIRONMENTAL AUDITORS

7.7 SUMMARY AND CONCLUSIONS

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CHAPTER 7

CORPORATE ENVIRONMENTAL ACCOUNTING CORPORATE ENVIRONMENTAL ACCOUNTING CORPORATE ENVIRONMENTAL ACCOUNTING CORPORATE ENVIRONMENTAL ACCOUNTING

AND REPORTINGAND REPORTINGAND REPORTINGAND REPORTING

7.1 INTRODUCTION

Accounting of environmental matters has been emerging as an important dimension

of corporate accounting and reporting practices. In many countries, the disclosure of

environmental information has been made mandatory. Companies, all over the world, have

also started reporting on the matter voluntarily. In the wake of growing legal and social

pressures, many companies in India have also made attempts to disclose their concern for the

environment in the annual reports or by some other mediums like environmental statements

or Internet. But, in the absence of any specific law, accounting standard or guideline on the

issue, these disclosures are subjective, inconsistent, and mainly descriptive and positive in

nature. In fact, recent research on corporate environmental reporting has shown that

environmental reporting in India is typically deficient and not of a standard to satisfy the

information needs of various classes of report users.

This Chapter explores whether a potential demand/supply imbalance is due to

differing perceptions between report users and preparers as to the various issues associated

with Environmental accounting and reporting (EAR) and importance of environmental

information to the users’ decision-making processes. For this purpose, the study surveyed the

attitudes of senior-executives in 100 large manufacturing companies in India (the preparers

group) on various issues relating to EAR. An .attempt was also made to obtain information

on EAR practices of these companies from the executives. In addition, opinions of the

selected individual Chartered Accountants (CAs), who were annual report users in different

capacities, were obtained. An attempt was made to examine whether an EAR expectation gap

exists within India.

7.2 SCOPE AND METHODOLOGY

This exploratory study dealing with EAR in India is based on primary data. One of

the objectives of the study was to examine the need for a specific regulatory framework

(including accounting guidelines, principles and standards) for EAR in India. For this

purpose, two questionnaires were designed keeping in mind guidelines issued by professional

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accounting bodies like the , United Nations’ Intergovernmental Working Group of Experts on

International Standards of Accounting and Reporting (ISAR), Financial Accounting

Standards Board (FASB), International Accounting Standards Committee (IASC), Canadian

Institute of Chartered Accountants (CICA) and Federation des Experts Comptables

Europeans (FEE). The questionnaires covered some general and, specific issues relating to

environmental accounting, environmental audit and disclosure of environmental information

by companies.

The first questionnaire was used to obtain opinions of chartered accountants (CAs) on

various issues relating to EAR. 200 CAs were selected from a directory prepared by the

institute of Chartered Accountants of India (ICAI) and the questionnaires were mailed to

them. Only two percent of the questionnaires were returned. Then, the CAs in Ahmedabad,

Gujarat region and some major cities were personally contacted. 150 responses were

received, of which 100 usable ones were used in final analysis. The profile of the responding

CAs‘ showed that they were mature, highly experienced and were related to the corporate

world in different capacities. They had sufficient knowledge of the corporate accounting and

reporting practices (as judged from their engagement in company audits) and were capable of

rendering opinions on various aspects of EAR due to their diverse knowledge and experience.

To analyze EAR practices followed by companies, another structured questionnaire

was framed on the same lines. The questionnaire was pilot tested in 10 large companies

having registered/corporate offices situated in Gujarat. It was found that none of these

companies had a practice of preparing environmental accounts for external reporting

purposes, though some of them used environmental cost information for internal decision-

making. It was also observed that most of them disclosed some environmental information

(though mainly qualitative) in the annual reports generally through the Director’s Report. In

view of these major findings, the questionnaire was adjusted to cover opinion seeking

questions on environmental accounting in addition to questions on actual environmental

disclosure practices. For rest of the survey, only this questionnaire was used. An attempt was

also made to obtain opinions of the executives on various issues involved.

The companies for the study were selected from the National stock exchange’s, and

Bombay stock exchange’s list of companies in India ranked on the basis of their annual

turnover. Top 500 companies were taken from this list. Manufacturing companies from both

public and private sectors were approached for the survey. Out of these 500 companies, 161

non-manufacturing concerns (other than those operating in power generation and mining

industries) were excluded, as the issue of environmental accounting might not be of much

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relevance to them; thus, giving a sample of 339 companies for the study. Since response

received through mail was not encouraging, personal visits were made to the

corporate/registered offices of companies situated in Gujarat and adjoining areas, Mumbai,

Rajasthan and Delhi. The response received was overwhelming. 105 responses were received,

of which four were rejected due to non-availability of the required information. Thus, 100

questionnaires were used for the final analysis, giving a response rate of 29.8 percent.

An idea about the representative nature of the study can be obtained by looking at the

characteristics of the companies, The reliability of the information supplied can be judged by

scanning the experience, designation, age and academic qualifications of the respondents.

The maximum percentage of` companies (about 17 percent) were from ‘general engineering

and automobiles’ industry, followed by ‘iron &, steel and other metals’ and ‘chemical,

fertilizers and pharmaceuticals’ industries. A significant number of the companies (11) were

from ‘oil, gas and petrochemicals’ industry, which is a polluting industry. In fact, an attempt

was made in the study to include more companies from the industries which are considered to

be the ‘most polluting industries’ according to the Environment (Protection) Rules, 1992, as

the issue of EAR is more relevant for them. In total, 58.42 percent of the companies were

from the most polluting industries. There were 20 public sector and 80 private sector

companies in the sample. Table-7.2.1 shows industry as well as sector-wise classification of

the companies.

The table indicates that companies from both the sectors were there in the sample,

depending upon the nature of industry and degree of Government or Private Player’s

participation in that industry. Thus, the study fairly represents various industries and sectors.

The responding companies were also found to be representative of the corporate sector in

India by looking at their other characteristics (e.g., region, paid-up capital and foreign

association).

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Table-7.2.1 Industry and Sector-wise Classification of the Companies

Number (Percent)

Industries Sector

Public Private

Coal and Mining, Cement 2 (33.3) 4(66.7)

Textiles - 5 (100)

Pager and Pager Products 2 (66.7) 1 (33.3)

Electronics, Electric Equipments - 9 (100)

Iron & Steel and other metals 3 (20) 12 (80)

General Engineering, and Automobiles 1 (5.9) 16 (94.1)

Chemicals, Fertilizers and Pharmaceuticals 2 (13.3) 13 (86.7)

Sugar, Breweries, Food Products and FMCG - 5 (100)

Oil & Gas and Petrochemicals . 7 (63.6) 4 (36.4)

Power Generation 3 (75) 1 (25)

Others (Diversified, Paints, tyres etc.) - 10 (100)

Total 20 (19.8) 80 (80.2)

Note : The percentage of companies in public and private sectors in each of the industries is

given within parentheses.

Regarding qualifications of the responding executives, about 80 percent of the

managers-had professional degrees (like CA, CS, CWA, CPA, CFA etc.) in commerce,

Therefore, relevant information from well qualified and knowledgeable executives was

obtained. The questionnaires were filled by mature and highly experienced senior of fields.

About 42 percent of the executives were from the ‘40-50 years’ age group and 27 executives

were having age above 50 years. About one-half of the executives had a total experience of

more than 20 years in the industry. Majority of the respondents held strategic positions (like

Director, President, VP or GM of Accounts/Finance Department) in the companies. The

profile increases the reliability of the information provided for the study.

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7.3 CONCEPT OF ENVIRONMENT

In literature, the term environment has been elucidated by various authors differently.

In this study, the term has been defined as natural physical surroundings and includes air,

water, land, flora, fauna and non-renewable resources such as fossil fuels and minerals. In

recent years, the environmental crisis has become a global issue. Now-a—days, there is a

greater degree of awareness and concern among people about environmental degradation.

This is evident from the fact that besides governmental agencies, a large number of non-

governmental organizations (NGOs) are also involved in the process of environmental

protection at global, national, regional and local levels. This Section seeks to present opinions

of the CAs and the executives on some general issues relating to environment. The Section is

further divided into two sub-sections. Sub-section l records responses of the CAs and the

managers on the importance of environment as a challenge for business. Sub-section 2 deals

with need for introducing environmental management system (EMS) in an organization.

7.3.1 ENVIRONMENT – A BIG CHALLENGE TO BUSINESS

In large number of major environmental problems like deforestation, over-

exploitation of resources and pollution, industrial and business activities are directly or

indirectly responsible. Because of growing awareness, business and industry cannot remain a

silent spectator to all these things. They have to take care of environment to survive and

grow. Majority of the CAs strongly agreed that environment is one of the most important

contemporary challenges faced by business. In their opinion, a business takes basic resources

from the environment and grows and survives in it. In turn, if it does not take steps to protect

the environment, it cannot continue to operate in the long run. This shows that senior

accounting professionals were aware of the increasing importance of environmental issues.

Only three CAs were of the opinion that the main objective of a business is profit-making and

issues relating to profit generation are more important for a business. A business has to solve

many other challenges relating to finance, competition and customers. Environment comes

only after solving these problems.

An overwhelming majority (about 97 percent) of the executives also agreed that

environment is one of the most important challenges faced by business these days. About

seven-tenths of them strongly believed this. They were of the opinion that due to growing

public awareness, governmental and non-governmental organizations as well as judicial

bodies have become sensitive towards environmental issues. Moreover, if a company has to

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operate in international market, it needs to prove that it is a green company and therefore,

environment is one of the crucial issues in these companies.

Establishment of EMS: Business and industry are also increasingly realizing their role

in sustainable development and hence, a new area of management is fast emerging known as

‘Corporate Environmental Management”1. Environmental impact assessment, environmental

risk management, environmental accounting and environmental audit are some of the

important areas falling within the scope of environmental management. The opinions of the

CAs on the need for introducing EMS in a business were obtained in the study. Almost all the

CAs (99 percent) agreed that companies should establish EMS. Majority of them (57.5

percent) strongly recommended this. The CAs felt that establishment of a good EMS helps in

maintaining clean and green environment around the factories, controlling pollution emission

and thereby meeting legal standards in this area. It facilitates compliance with various legal

requirements set by Pollution Control Boards (PCBs). Establishment of EMS is also a pre-

condition to obtain ISO-14001 certificate, which most of the big companies are getting these

days. Some of them felt that EMS helps in satisfying the government, the NGOs and the

society at large that business is meeting its social responsibilities, Only one respondent felt

that establishment of EMS is a costly affair and businesses, particularly small entities, do not

require it. An examination of actual practices showed that a large majority of the companies

(89.1 l percent) already had EMS in their organizations, while another four companies were

planning to introduce it in near future. The executives gave various reasons for their

companies’ decisions to establish EMS like ‘to meet legal requirements relating to

environment, ‘concern for environment’, required for obtaining ISO-14000 certificates’,

‘growing legal, social and even financial pressures’, The executives belonging to the

polluting industries felt that existence of an efficient system of environmental management

helps in satisfying regulatory authorities about environmental concern of the organization.

Only seven companies didn’t have a formal EMS in place. The main reason advanced for not

introducing EMS was that the company belonged to a non-polluting industry.

7.4 ENVIRONMENTAL ACCOUNTING

The previous Section has revealed that a large majority of the respondents considered

environment as one of the most important challenges faced by business these days. Increasing

social, legal, global and financial pressures have led these companies to initiate steps to

protect and conserve environment. These measures involve some costs, but at the same time,

give many direct or indirect benefits to the company as well as to the society. To provide for

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impact of these steps on. trading results and financial position of a company, it is necessary

to introduce some form of accounting for the environment. It has been observed in Chapter 3

that broadly the concept of environmental accounting can be discussed at two levels-

National Accounting level (macro level of environmental accounting) and Corporate

Accounting level (micro level of environmental accounting). Corporate level again includes 2

parts-Environmental financial accounting (used for external reporting purposes) and

Environmental management accounting (used for internal decision-making). The present

study covers environmental accounting at corporate level only, i.e. financial accounting level

and management accounting level. Environmental accounting has been defined as

identification, measurement, recognition and disclosure of environmental costs, benefits,

assets and liabilities.

In this Section, an attempt has been made to present environmental accounting

practices of the selected companies. The opinions of the CAs and the senior preparers of

accounts were also obtained on some specific issues relating to accounting for the

environment. This Section is further divided into 8 sub-sections. Sub-sectional seeks to find

whether existing financial accounting framework is comprehensive enough to deal with

environmental issues. Sub-section 2 analyzes environmental accounting expectation gap in

India by comparing opinions of the CAs regarding adoption of environmental accounting

system by companies with actual environmental accounting practices of the sample

companies. Sub-section 3 presents opinions of` the respondents on the importance of

environmental information in decision-making. Sub-section 4 deals with identification of

environmental costs. Sub-section 5 records viewpoints of the respondents on treatment of

these costs in the books of accounts. This Sub- section also takes up some specific issues

relating to environmental accounting like treatment of prior-period environmental costs and

recovery and impairment of environmental assets. Sub-section-6 covers the recognition of

environmental benefits. Sub—section 7 discusses treatment of social costs by the companies.

Finally, Sub-section 8 analyses opinions of the respondents on recognition and measurement

of environmental liabilities.

7.4.1 COMPREHENSIVENESS OF FINANCIAL ACCOUNTING

FRAMEWORK

Conventionally financial statements are prepared within the framework provided by

recognized standard setting bodies in various countries. These statements are prepared for

investors, creditors and other stakeholders. However, the incorporation of` environmental

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costs, benefits and other issues into the mainstream of financial accounting is still at an

embryonic stage. It is commonly advocated that the existing accounting framework is not

comprehensive enough to deal with environmental costs, benefits, assets, liabilities and

contingencies. Till date, in India, neither Company Law nor any accounting standard

prescribes any accounting treatment or disclosure technique for environmental matters in the

corporate financial statements. This sub-section attempts to present opinions of the senior

preparers of` accounts on the adequacy of the existing financial accounting framework to deal

with environmental issues.

More than four-fifths of the executives felt that the current financial accounting

framework in India cannot deal with all the issues relating to accounting for the environment.

88 percent of the CAs were also of the same opinion. These accountants supported

development of a separate framework for environmental accounting to find ways to monitor

the use and value of environmental resources both in terms of raw material consumed and

damage inflicted upon environment. In their opinion, though the financial accounting

framework can be used broadly for dealing with general environmental issues, some specific

environment related problems (like separating environmental costs from other costs or

measurement of some less tangible environmental costs and benefits) cannot be handled

effectively within this framework. For handling these problems, a separate environmental

accounting framework is required within the broad financial accounting framework.

Further about 83 percent of the executives and 88.6 percent of the CAs supported

development of a separate standard on environmental accounting or amendments in the

existing standards to incorporate environmental matters. They felt that this would help in

dealing with specific issues relating to accounting for environment. They were of the opinion,

that in the absence of specific standards, these issues are handled in the books of accounts

according to the discretion of the managers and it may lead to manipulation of results.

However, some of the respondents were of the opinion that only a few adjustments in the

existing financial accounting framework can make it adequate enough to deal with

environmental problems.

7.4.2 ADOPTION OF ENVIRONMENTAL ACCOUNTING SYSTEM

The existing research on the issue shows that till date, very few companies

incorporate environmental accounts formally in their financial statements. Though some

companies, have started reporting on environmental issues, the preparation of environmental

accounts for financial reporting purposes is still not common. This sub-section records

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opinions of the CAs on the main reasons for failure of many companies to incorporate

environmental accounting formally in their financial statements. Further, actual

environmental accounting practices of the responding companies have also been examined in

this part.

According to the CAs, the most important reason for failure to prepare environmental

accounts is ‘voluntary nature of environmental accounting’. About 63 percent of the qualified

accountants gave one of the first three ranks to this reason. Two more reasons considered

important and given first three ranks by about 55 percent of the CAs were ‘ignorance of

benefits of environmental accounting’ and ‘lack of clear-cut government policy on this issue’.

The CAs were of the view that companies in India tend to lack initiative in this matter. They

would introduce environmental accounting only if` it is made mandatory. Moreover, people

are still not aware of the benefits of environmental accounting (Table-7.4.1).

In the opinion of the respondents, clear-cut government policy and framing of a

separate accounting standard- on the issue would be essential to prompt companies to use this

concept. Some respondents gave other reasons also like, ‘costs involved in preparation; of

environmental accounts’ ‘reluctance on part of top management’, insensitivity toward

environmental issues’ and ‘no direct benefit to companies’.

Table-7.4.1 Reasons for Failure to Use Environmental Accounting : CA’s Views

Number

Reasons Ranks

0 1 2 3 4 5 6 a) Lack of accounting standards 20 14 22 18 11 14 2 b) Ignorance of benefits of environmental accounting 14 24 10 22 19 11 - c) Voluntary nature of environmental accounting 15 34 14 16 9 13 d) Lack of clear cut government’s policy on the issue 19 23 18 15 19 7 e) Difficulty in measuring environmental costs and benefits

objectively 17 17 19 12 15 21

f) Any other 89 11 - - - - 1

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Percentage

Reasons Ranks

0 1 2 3 4 5 6 a) Lack of accounting standards (19.8) (13.09) (21.8) (17.8) (10.9) (13.9) (2)

b) Ignorance of benefits of environmental accounting

(13.8) (23.8) (9.9) (21.8) (18.8) (10.9) -

c) Voluntary nature of environmental accounting

(14.9) (33.7) (13.9) (15.8) 8.9 (12.9)

d) Lack of clear cut government’s policy on the issue

(18.8) (22.8) (17.8) (14.9) (18.8) (6.9)

e) Difficulty in measuring environmental costs and benefits objectively

(16.8) (16.8) (18.8) (11.9) (14.9) (20.8)

f) Any other (88.1) (10.9) - - - - (1) The CAs was further asked whether a company should adopt environmental

accounting ‘system and if` yes, what are the potential benefits of adopting this system.-

Almost all the CAs (97.03 percent) felt that a company should use environmental accounting

system. One of the senior practicing CA was of the opinion, “Though at this stage it seems

difficult for a company to use this system, in the long run, preparation of environmental

accounts is beneficial not only for the concern, but also for various stakeholders who are

interested in environmental information”. Majority of` the qualified accountants considered

‘helps in complying with environmental laws’ as an important benefit of preparing

environmental accounts (Graph-7.4.2). The other two benefits regarded important by them

were, “helps management in decision-making’ and ‘provides better estimates of cost of

producing 'a product’. Some CAs mentioned other benefits of preparing these accounts also

like ‘it helps business in meeting its social responsibilities, ‘required in global business

perspective` and ‘helps in enhancing image of the company’.

Only three CAs didn’t find any need for preparing separate environmental accounts

mainly because it is not required by law. In their opinion, preparation of environmental

accounts is costly as well as a time-consuming affair and is not suitable for entities

particularly small business; Moreover, in the absence of any accounting standard or

guideline, it is difficult to measure environmental information. In such a scenario, preparation

of environmental accounts will not serve any purpose.

Actual Practices

The practices of the sample companies relating to accounting for the environment

have been depicted in Table-7.4.3.

did not prepare environment related accounts. About three

mandatory nature of environmental accounting as a justification for not preparing these

accounts (

a)

b) c) d) e) f) g)

a)

b)

c)

d) e) f)

g)

The table



ccounts (Graph

Provides better estimates of total cost of producing a product

Helps management in decision Improves pricing of the product Increase profitability Gives competitive advantage Helps in complying with environmental laws Any Other

Reasons

Provides better estimates of total cost of producing a product

Helps management in decision-making

Improves pricing of the product

Increase profitability Gives competitive advantage Helps in complying with

environmental laws Any Other

Preparation of Environmental Accounts by Sample Companies

The table shows that a substantially high proportion of the companies (93.1 percent)



Graph-7.4.1).

Benefits of Environmental Accounting : CAs’ Opinions

Reasons

Provides better estimates of total cost of producing a

Helps management in decisionImproves pricing of the product Increase profitability Gives competitive advantageHelps in complying with environmental laws Any Other

Reasons


Helps management in making

Improves pricing of the

Increase profitability Gives competitive advantageHelps in complying with environmental laws


shows that a substantially high proportion of the companies (93.1 percent)




Reasons


Helps management in decision-making Improves pricing of the product

Gives competitive advantage Helps in complying with environmental laws


(22.7)

Helps management in (17.5)

Improves pricing of the (36.1)

(37.1)Gives competitive advantage (22.7)Helps in complying with (9.3)

(88.7)


Yes , 6.90%




Table-7.Benefits of Environmental Accounting : CAs’ Opinions


making

Helps in complying with environmental laws

0 (22.7) (16.5)

(17.5) (26.8)

(36.1) (2.1)

(37.1) (3.1)(22.7) (9.3)(9.3) (42.3)

(88.7) (10.3)

Graph-Preparation of Environmental Accounts by Sample Companies

Yes , 6.90%


did not prepare environment related accounts. About three-fourths of the managers gave non


7.4.2 Benefits of Environmental Accounting : CAs’ Opinions

0 Provides better estimates of total cost of producing a 22

17 35 36 22 9 86

1 2 (16.5) (22.7)

(26.8) (18.6)

(2.1) (8.3)

(3.1) (4.1)(9.3) (12.4)(42.3) (19.6)

(10.3) -

-7.4.1 Preparation of Environmental Accounts by Sample Companies

No, 93.10%


fourths of the managers gave non



1 2 16 22

26 18 2 8 3 4 9 12 41 19 10 -

Ranks 3

(22.7) (15.5)

(18.6) (13.4)

(8.3) (19.6)

(4.1) (5.2) (12.4) (16.5) (19.6) (7.2)

-



fourths of the managers gave non



Ranks 3 4 15 9

13 14 19 11 5 13 16 14 7 5

- -

4

(9.3)

(14.4)

(11.3)

(13.4) (14.4) (5.2)

-


187


fourths of the managers gave non-


Number

5 6 10 3

14 7 2 11 17 5 13 10 2514 17 7

2 14 - 1

Percent

5 (10.3) (3.1)

(7.2) (2.1)

(17.5) (5.2)

(10.3) (22.8)(17.5) (7.2)(2.1) (14.4)

- (1.0)

187


-


Number

25

14

Percent

6 (3.1)

(2.1)

(5.2)

(22.8) (7.2) (14.4)

(1.0)

188

About 24 percent of the executives mentioned ‘no accounting standard and guideline’

as the main reason for not preparing these accounts. In the absence of any specific standard or

guideline in this area, these officials found it difficult to incorporate environmental issues

formally in the annual accounts. In this situation, if environmental statements are prepared,

there will be lack of any credibility, objectivity and comparability in the information provided

in these statements. It is to be noted that a negligible proportion of the managers advanced

cost and time constraints as explanations for not preparing these statements. Some executives

gave other reasons also like ‘inadequate database’, ‘no effect on profitability ‘costing

problems’.

Only seven executives informed that their companies prepared environmental

accounts. But during interviews and discussions, it was found that even these companies did

not have practice of incorporating environmental accounts in the financial statements for

external reporting purposes. However, these companies generated some environmental

figures for internal decision-making purposes. Further discussions on the issue revealed that

about 57 percent of the companies had practice of generating and using internal

environmental statements for managerial decision-making.

Corporate EAR Expectation Gap

Table-7.4.3 Reasons for not preparing Environmental Accounts : Executives’ perceptions

Number

Reasons Ranks

0 1 2 3 4 5 a) Expensive 69 2 - 3 4 17

b) Time consuming 71 2 3 14 4 c) Not required by Law 5 72 12 4 1 1 d) No accounting standards of guidelines 43 23 21 3 3 2 e) Difficulty in measuring environmental costs and benefits 61 14 7 12 1 - f) Any Other 76 10 4 1 - -

Percent

Reasons Ranks

0 1 2 3 4 5 a) Expensive (72.6) (2.1) - (3.2) (4.2) (17.9)

b) Time consuming (74.7) (2.1) (3.2) (14.7) (4.2) c) Not required by Law (5.3) (75.8) (12.6) (4.2) (1.1) (1.1) d) No accounting standards of guidelines (45.3) (24.2) (22.1) (3.2) (3.2) (2.2) e) Difficulty in measuring environmental costs

and benefits (64.2) (14.7) (7.4) (12.6) (1.1) -

f) Any Other (83.5) (11) (4.4) (1.1) - -

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Thus, a significant environmental accounting expectation gap exists in India. Though

about 97 percent of the CAs felt that environmental accounts. should be prepared, but 93

percent of the companies did not prepare these accounts for external reporting purposes.

7.4.3 ENVIRONMENTAL COSTS

Some professional bodies and authors include external as well as internal costs in the

definition of environmental costs. However, the present study is concerned with internal costs

only, which a company actually incurs on protection or conservation of environment

(whether voluntarily or under legal requirement). It, therefore, ignores social/external

environmental costs. In the present study, environmental costs have been defined as costs of

steps taken or required to be taken by a company, to reduce adverse impact of its activities on

the environment as well as costs driven by the environmental objectives of the enterprise.

In this sub-section, an attempt has been made to examine views of the respondents on

the importance of environmental cost information in making various business decisions. A

list of five vital business decisions was given in the questionnaire. The respondents were

asked whether environmental information generated by environmental accounting will be

useful for management in making these decisions. Their views have been presented inTable-

7.4.4 and Table-7.4.5.

Table-7.4.4

Importance of Environmental Cost Information in Decision-making : CA’s Views Number

Business Decisions Yes No N.A. a) Appraisal of investment for environmental risks 90 8 3

b) Evaluation of environmental performance of a company 88 5 8 c) Planning cost reduction 59 35 7 d) Assessing environmental impact of a company’s projects 91 4 6 e) Designing various processes using environmental friendly technologies 97 1 3 f) Any Other - - -

Percent

Business Decisions Yes No N.A. a) Appraisal of investment for environmental risks (89.11) (7.92) (2.97)

b) Evaluation of environmental performance of a company (87.13) (4.95) (7.92) c) Planning cost reduction (58.42) (34.65) (6.93) d) Assessing environmental impact of a company’s projects (90.1) (3.96) (5.94) e) Designing various processes using environmental friendly technologies (96.04) (0.99) (2.97) f) Any Other - - -

The above table shows that an overwhelming majority (96.04 percent) of the CAs

found usefulness of environmental cost information in ‘designing various processes using

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environmental friendly technologies. According to EPA also, The design of a process or

product significantly affects environmental costs and performance. Many companies are

adopting ‘design for the environment or ‘life cycle design’ programme to take environmental

considerations into accounts at an early stage. Thus, making environmental cost and

performance information available to designers can facilitate the design of environmentally

preferable processes and products.” 2 About 90 percent of the CAs felt that this information

facilitates making other decisions also, e.g., environmental impact assessment or appraisal of

investments for environmental risks. Only 59 responding CAs recognized usefulness of these

details in ‘planning cost reductions’

Table-7.4.5 Importance of Environmental Cos Information in Decision-making : Executives’ opinions

Number

Decision Areas Yes No N.A.

a) Appraisal of investment for environmental risks 93 3 5

b) Evaluation of environmental performance of a company 94 3 4

c) Planning cost reduction 71 25 5

d) Assessing environmental impact of a company’s projects 98 3 -

e) Designing various processes using environmental friendly technologies 94 3 4

f) Any Other - - -

Percent

Decision Areas Yes No N.A.

a) Appraisal of investment for environmental risks (92.08) (2.97) (4.95)

b) Evaluation of environmental performance of a company (93.07) (2.97) (3.96)

c) Planning cost reduction (70.30) (24.75) (4.95)

d) Assessing environmental impact of a company’s projects (97.03) (2.97) -

e) Designing various processes using environmental friendly

technologies

(93.07) (2.97) (3.96)

f) Any Other - - -

An analysis of the responses given in above shows that all but three executives were

convinced about the usefulness of environmental Cost information in ‘assessing

environmental impact of a company’s projects’. Other important decisions where these

details can be fruitfully used according to them were, ‘appraisal of investment for

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environmental risks’, ‘evaluation of environmental performance of a `company’ and

‘designing of various processes using environmental friendly technologies.

7.4.4 IDENTIFICATION OF ENVIRONMENTAL COSTS

One of the major barriers to the adoption of cleaner production technologies and

eco—efficiency is that firms do not often know the full environmental costs of operating their

business. As a result, they do not know the financial benefits that can arise by reducing their

environmental impacts (by using cleaner technologies, environmental friendly processes or

waste management). The identification of environmental expenses not only provides a

comprehensive picture of the efforts that have been undertaken by a business to protect the

environment, but also helps in its proper treatment in books of` accounts. Some expenses like

those incurred on compliance with environmental laws or purchase of` pollution control

equipment can easily be identified as environmental costs. But others cannot be easily

categorized as environmental costs like cost of` purchasing equipment which is energy

efficient. These costs are normal business costs, but some additional amount may have to be

spent keeping in mind environmental considerations. It is difficult to segregate these costs

into normal business expenditure and environmental costs. The views of the respondents on

the need to bifurcate these expenses into ordinary and environmental costs were collected in

the study.

About 88 percent of the responding CAs and two-thirds of the officials felt that these

combined costs should be bifurcated into environmental and normal business expenses. In

their opinion, segregation of combined cost is necessary for getting information about total

environmental costs incurred by a company. lf a business really wants to know true

environmental costs and report them to the stakeholders, it needs to separate all

environmental costs from other business expenses. Some of them found it beneficial in

assessing environmental performance of a company and in fixing responsibilities of different

managers. The executives in environmentally sensitive industries felt that this segregation

gives an idea about a company’s total spending on protection and improvement of

environment und this information is required to reduce pressures from various governmental

and non-governmental bodies. Some respondents were not in favor of bifurcation of

combined costs as it is not required by law. They also felt that in the absence of any

accounting standard or guideline, this segregation may lead to confusion and manipulation of

accounts.

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Majority of those respondents who favored bifurcation of environmental and non

environmental expenses considered ‘some accounting standard or guideline’ as the most

appropriate basis for bifurcation. In their opinion, without a standard or guideline, the

bifurcation will give discretion to management and may lead to manipulation of accounts. 3‘Internal mechanism’ for segregation of combined expenses was preferred by some of the

executives. They were of the view that companies should define what should constitute an

environmental cost and how to classify it, on the basis of their goals and intended uses of

environmental accounting. For example, if a company’s wants to encourage pollution

prevention in capital budgeting, it might consider distinguishing environmental costs that can

be avoided by pollution prevention investments from environmental costs related to

remedying environmental contamination that has already occurred. But for product costing

purposes, such a distinction might not be necessary because both are costs of producing the

goods or service. Four executives suggested that a combination of above methods can be used

according to the circumstances of the case.

7.4.5 TREATMENT OF ENVIRONMENTAL COSTS IN BOOKS OF

ACCOUNTS

After identifying environmental costs, the next step is their proper recognition in the

books of accounts. This sub-section presents the views of the respondents on treatment of

these costs in the books of accounts, i.e. expensing, capitalization and amortization of

environmental expenses. Table 7.4.6 summarizes these opinions.

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Table-7.4.6 Treatment of Environmental Costs in Financial Statements

Number

Treatment in the Financial Statements Responses (Yes)

1. Expensing of environmental expenses with no future benefits 93 94 2. Capitalization of Environmental Costs incurred on (a) Increasing capacity of an existing assets

(b) Improving safety of an existing asset (c) Improving efficiency of an existing asset (d) Reducing environmental contamination likely to occur as a result of

future operations (e) Preventing environmental pollution (f) Conserving the environment

91 61 75

60 60 62

88 53 73

66 64 62

3 Including related environmental costs in the cost of an existing asset 74 60 4. Amortization of environmental costs

(a) 1-2 years (b) 3-4 years (c) Any other frequency (d) As per standards

8 30 -

49

4 19 -

69 5. Treatment of pollution permits as intangible assets 43 28 6. Treatment of environmental costs relating to prior period as per existing

accounting standards 81 86

Percent

Treatment in the Financial Statements Responses (Yes)

1. Expensing of environmental expenses with no future benefits (92.1) (93.07)

2. Capitalization of Environmental Costs incurred on (g) Increasing capacity of an existing assets

(h) Improving safety of an existing asset (i) Improving efficiency of an existing asset (j) Reducing environmental contamination likely to occur as a result

of future operations (k) Preventing environmental pollution (l) Conserving the environment

(90.1) (60.4) (74.3)

(59.4) (59.4) (61.4)

(87.13) (52.48) (72.28)

(65.35) (63.37) (61.39)

3 Including related environmental costs in the cost of an existing asset (73.3)

(59.4)

4. Amortization of environmental costs (e) 1-2 years (f) 3-4 years (g) Any other frequency (h) As per standards

(9.1) (34.4)

- (56.3)

(4.4) (18.8)

- (76.6)

5. Treatment of pollution permits as intangible assets (42.6) (27.7) 6. Treatment of environmental costs relating to prior period as per

existing accounting standards (80.2) (85.1)

The number and percentage in the table shows the respondents answering in a affirmative to a

given treatment of expenses.

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1. Expensing of Environmental Costs

As per financial accounting principles, the expenses which are recurring in nature and

do not give future economic benefits to the concern should be expensed in the year in which

they are incurred.

According to ISAR guidelines also, an environmental cost that does not meet the

criteria for recognition as an asset should be charged to Profit and Loss Account4. As shown

in the table, majority of the respondents felt that the same financial accounting principle

should be followed in case of environmental costs also. Only some managers argued that

generally environmental layouts involve huge amount and if charged to one year’s revenue

account, it will reduce the profits of that year substantially. Therefore, these costs should be

treated as deferred revenue expenditure. Moreover, non-recurring environmental costs can be

capitalized, even when they do not give future benefits to the concern.5

2. Capitalization of Environmental Costs

According to ISAR guidelines, “Environmental costs should be capitalized, if they relate,

directly or indirectly, to future economic benefits that will flow to an enterprise through:

• Increasing the capacity or improving the safety or efficiency of other assets owned by

the enterprise;

• Reducing or preventing environmental contamination likely to occur as a result of

future operations; or

• Conserving the environment?

The table shows that a large majority of the CAs and the executives were of the view

that environmental expenditures incurred on ‘increasing capacity of an existing asset’ should

be capitalized. These costs lead to future economic benefits for a company and hence, meet

the criteria for recognition as an asset. Most of them also favored capitalization of

environmental costs for ‘improving efficiency of an existing asset’ as it will increase future

economic benefits either through cost reduction or increase in revenues.6 Regarding all other

environmental costs, only about 60 percent of the respondents favored their capitalization,

According to them these costs (e.g., cost incurred on conserving the environment or

improving safety of an existing asset) though, do not lead to future economic benefits, should

be capitalized as they result in benefits to society in future.

Some of them argued that increasing legal and social pressures have compelled the

companies to incur these costs. Since these costs are necessary for the very existence of the

company, these should be capitalized. They were of the view that if` these expenses involve

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substantial outlays and result in asset creation, these should be capitalized even when

company is not getting future economic benefits (for example, expenditure in establishing

Effluent Treatment Plants (ETPs).

About 40 percent of the respondents did not favor capitalization of these expenses.

They felt that the only criterion for recognition of an asset is that it should result in flow of

economic benefits to the concern in future. They were of the opinion that even if some asset

is created, it is a kind of NPA (non-performing asset) and hence, need not be shown as an

asset in the Balance Sheet. Moreover, charging these expenses to the revenue account will

give tax benefits to the company.

In nutshell, any expenditure for survival and continuation of business is necessary for

the very existence of the business and hence, should be capitalised because it would give

indirect long term benefits to the concern. Without incurring these costs, the business cannot

be continued in the future. Therefore, keeping in mind going concern assumption, these

expenses should be capitalised. But routine or recurring expenses should be charged to the

revenue account in the same year in which they are incurred.

3. Depreciation/Amortization of Environmental Assets

The capitalised environmental costs (i.e., environmental assets) should be amortized

over a reasonable period of time. Majority of the respondents favored amortization over a

short period of time. They were of the view that due to rapidly changing environmental laws

and technologies for environmental protection, it is financially prudent to write-off these

assets as early as possible. The responding CAs and the managers emphasised the need for

specific guidelines or standard about the period and method of` amortization of

environmental assets. These guidelines may be given either in the Company Law (like other

assets) or in relevant accounting standards.

4. Treatment of Pollution Permits as Intangible Assets

Many countries are now considering to control greenhouse effects and CO2 targets

through regulation of business entities using carbon emission rationing system where they

allocate carbon credits or permits to them for the emission of a certain quantity of greenhouse

gases in a particular period (i.e. a permitted quota), or by approving certain organizations as

being able to issue legitimate carbon credits (called ‘abatement certificates’). The

environment policy-related carbon trading has entered India also with many companies in

India have started establishing systems for reducing carbon dioxide emissions in the

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atmosphere. Many related accounting issues have arisen due to carbon trading which must be

answered by accountants in India- one of the most important is the accounting treatment of

emission certificates which are intangible assets like patents or copyrights.

The respondents were asked whether pollution permits or emission rights should be

treated as intangible assets, About 55 percent of the responding accountants and seven- tenths

of the executives did not support treatment of pollution permits or emission rights as

intangible assets. The executives informed that generally acquiring pollution permits or

emission rights is a routine thing for factories. Manufacturing concerns have to get these

permits to comply with various environmental laws. Therefore, expenses incurred in getting

these permits should be treated as recurring cost and charged to P & L Account in the same

year only.

Even those respondents who favored treatment of these permits and rights as

intangible assets said that this should be done only when these rights are acquired for a longer

period. Most of the managers strongly recommended that government should give these

rights for a longer period because acquiring them every year is a hassle and wastage of time

and resources.

They were of the view that these permits should at least be given for three years,

though yearly environmental audit by recognized authorities can be conducted to see that

pollution or emission level is within the prescribed limits. In case of default, the permit can

be, cancelled by the concerned State Pollution Control Board (SCPB).

5. Prior Period Costs

In many cases, an environmental cost may relate to the damage that has occurred in a

prior period, e.g., an activity in a prior period which now requires clean up or cost of

disposing or treating hazardous waste created in a prior period. Current accounting standards

specify that a cost related to a prior period should not be treated as prior period adjustment

unless there is some fundamental accounting error. This part presents the views of` the

responding CAs and the executives on treatment of these costs in the books of` accounts.

The respondents generally favoured application of current accounting standards here

i.e., environmental costs that relate to prior period/periods should not be treated as prior

period adjustment unless there is a fundamental accounting error. However, some

respondents did not support treatment of the expenses related to a prior period as current

expenses. There are many reasons for their viewpoint. Firstly, in their opinion, some

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companies pay ·a significant portion of their total environmental cost to clean up pollution

caused decades ago.

These expenses are often substantial and including them in current year’s profit

statement will reduce profits drastically. Secondly, loading these expenses into product cost

fails to accurately measure the profitability of the product, facility or division. The

respondents felt that managers should not be held responsible for the costs beyond their

control. Some executives were of the view that if these costs are significant and benefits

relating to them have been derived in the past, these costs can be treated as prior period costs.

6. Recovery and Impairment of Environmental Assets

According to ISAR guidelines, environmental assets should be tested for impairment

and should be written down to their recoverable amount. Similarly, when an environmental

cost is capitalized and included as an integral part of another asset, the combined asset should

be tested for impairment and, wherever appropriate, written down to its recoverable amount.

This part presents opinions of the accountants on recovery and impairment of environmental

assets.

The respondents generally favoured testing of environmental assets for impairment.

However, some of them believed that while recognition and measurement of environmental

asset impairment involves the same principles as other forms of impairment, the uncertainties

may be greater here. About 75 percent of them felt that if appropriate, environmental assets

should be written down to their recoverable amount. Almost identical responses were

received in case of recovery and impairment of combined assets. It is to be noted that about

one-tenth of the CAs was indecisive on the issue. Some of the respondents, who favored

testing of environmental assets for impairment, did not support writing these assets in the

financial statements at their recoverable values. They felt that it is against the going-concern

assumption. However, some of them said that the recoverable values can be shown in the

footnotes.

7.4.6 RECOGNITION OF ENVIRONMENTAL BENEFITS

Most of the environmental costs incurred by a company do not result in direct and

immediate financial benefits to the company, although they may give benefits to the society.

But, there are some environmental costs that give financial benefits to the company in future,

e.g., use of energy efficient equipment and machines may lead to lesser running cost.

Similarly, steps taken to conserve natural resources or for managing waste may give financial

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benefits to the company.7 In a given period, there can be three types of environmental

benefits: income, current savings and cost avoidance.8 It has been observed that companies

generally talk about continuously increasing environmental costs, but even financial benefits

resulting from them are never recognised in the financial statements or otherwise. Eco-

efficiency suggests that in addition to reporting environmental costs, it is also necessary to

report environmental benefits, so that the user of data can get full information to take relevant

decisions. By comparing benefits produced with environmental costs incurred in a given

period, a type of environmental financial statement can be produced. Managers can use this

statement to assess environmental performance of the company and potential for progress,

This sub-section records opinions of the CAs and the executives on the recognition of

expected financial benefits of environmental expenses (eg., potential cost savings from using

cleaner technologies) in the financial statements.

64.4 percent of the CAs did not support recognition of future economic benefits of

environmental expenses. Most of them felt that due to the ‘principle of conservatism’,

expected future benefits from environmental costs should be ignored. Other reasons given by

some of them were, no accounting standard requires it`, “no need to recognize it separately in

financial statements’, ‘financial benefits not to be considered in incurring social costs’ and

‘intangible nature of most of the environmental benefits.

More than one-third of the CAs was of the view that current environmental financial

benefits should be recognised in the financial statements. They gave different reasons for

their viewpoint like, ‘it will help in cost-benefit analysis’, ‘helps in assessing environmental

performance of a concern’ and ‘will encourage use of environmental accounting concept’.

These accountants were in favor of disclosing current financial benefits from environmental

costs in the financial statements and future financial benefits either by way of footnotes to the

financial statements or in separate environmental statements. In their opinion, this

information is very useful for external stakeholders as well as managers in decision-making.

The viewpoints of the CAs on the issue have been summarized in table 7.4.7

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Table-7.4.7 Reasons for recognition of Environmental Benefits : CA’s Views

Reasons Number of CAs

A. For recognizing environmental benefits

(a) Helps in cost-benefits analysis 8

(b) Helps in assessing company’s environmental performance 3

(c) Required under principle of full disclosure 1

(d) Any other 6

B. For not recognizing environmental benefits

(a) Principle of conservatism 42

(b) Automatic accounting in financial statements 4

(c) Financial benefits not to be considered in incurring social costs 4

(d) No accounting standard requires in it 2

About 53 percent of the executives were of the view that these benefits should be

separately recognized in the financial statements. They gave various reasons for their

viewpoint like ‘it is necessary for cost-benefit analysis’ and ‘will motivate a company to

spend more on environment’. However, about 46 percent of the respondents did not support

recognition of these benefits in the financial statements because of differing reasons like

‘difficulty in measurement’; ‘lack of accounting standards’ and ‘principle of` conservatism’.

The viewpoints of these executives have been summarized in table 7.4.7.

7.4.7 SOCIAL/EXTERNAL COSTS

Social costs are costs of adverse impact of a business’s activities on the society, for

which it is not legally. Accountable (e.g., environmental degradation or adverse impact on the

health of human beings, for which business is not legally liable). Recognition and

measurement of these costs is a difficult thing as these cost are qualitative in nature and also,

no accounting standard or guideline provides any recommendation in this regard. Though

methods of valuation/measurement of these costs and not in the scope of this study, an

attempt has been made in this part to analyze general opinions of the respondents on the

issue. Their views have been presented in table 7.4.9.

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Table-7.4.8 Reasons for Recognition of Environmental Benefits : Executives’ Opinion

Reasons Number of CAs A. For recognizing environmental benefits (a) Highlights activities of the company for environment 4 (b) Essential for the concept of environmental accounting 2 (c) Necessary for cost-benefit analysis 9 (d) Will motivate company to spend more on environment 6 (e) Will Provide environment related information to stakeholders 15 B. For not recognizing environmental benefits (a) Difficulty in measuring 11 (b) Lack of accounting standards 4 (c) Automatic recording is there 5 (d) External disclosure not necessary 10 (e) Principle of conservation 10

As depicted in the table, a large majority of the CAs (96 percent) felt that a company

should try to determine external adverse impacts of its activities. They were of the opinion

that business is a part of society and as -a good corporate citizen, it is a duty of the company

to see that its activities are not harmful for the society. One senior qualified accountant was

of the view, ‘Such an accounting will give human face to the company and will add to its

competitive position in the market’ Only four CAs were not in favour of determining social

costs because of difficulties involved in it. They also argued that determination of these costs

is not required by law.

Table-7.4.9 Social Costs / Externalities

Number

Area Response (Yes) CA’s views Actual

Practices 1 Determination of Social Costs 97 81 2. Valuation of Social Costs 88 42 3. Considering Social Costs in Decision-making 94 90 4. Internalizing social costs 96 97

(Percent)

Area Response (Yes) CA’s views Actual

Practices 1 Determination of Social Costs (96.1) (80.2) 2. Valuation of Social Costs (87.1) (41.6) 3. Considering Social Costs in Decision-making (93.1) (89.1) 4. Internalizing social costs (95.05) (96.1)

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Regarding, actual practices of the company, about 80 percent of the companies

determined external adverse impact of their activities. Only about 17 percent of the

companies informed that they did not follow the practice of determining these costs mainly

because of less polluting nature of the company. Some of the companies did not follow this

practice as it was not required by law.

The CAs were further asked whether a company should try to value these social costs.

As evident from the table, majority .(87.l percent) of the CAs felt that though it is difficult to

value external costs, some method should be used by companies for this

valuation/measurement. In their opinion, only after valuation of these costs, a company can

think of reducing these costs or compensating the society for adverse impacts of its activities.

Only nine CAs felt that companies should not waste time and resources in valuation of

external costs because, firstly, there is no accounting standard on valuation of social cost and

secondly, law does not require it. An overwhelming majority of the CAs (93 percent)

favored consideration of social/external costs in making various strategic business decisions

like before starting a new project or using a technology.

When actual practices were analysed, it was found that more than 53 percent of the

companies did not try to value these costs. The executives belonging to these companies

argued that in the absence of any accounting standard or measuring technique, it was not only

difficult, but useless to value these social costs. However, 42 executives informed that their

companies tried to evaluate these externalities and accordingly took steps to mitigate

adversity of these impacts. They believed that valuation of social costs helped their

companies to decide about the amount to be spent on these issues. A large majority of the

companies claimed that social costs are considered in making crucial business- decisions. The

senior executives informed that considering social costs is sometimes a legal compulsion, but

many a times, this is done voluntarily also keeping in mind social and environmental

objectives of the company. Environmental impact assessment is an important part of project

planning and management.

The boundaries of social costs are not static. Many costs, which were external/ social

in the past, are now internal costs for a business due to changes in legislation. In the same

way, due to growing legal and social pressures, most of the external environmental costs may

become internal in future (e.g., companies will have to bear penalties or clean up pollutions).

Almost all the qualified accountants and the senior executives were of the view that most of

these external costs will become internal in future. They felt that society is becoming aware

of the environmental issues and unless a business itself takes some voluntary measures to

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prevent and reduce environmental pollution or for conservation of natural resources, it may

be forced to do so by law. Majority of them felt that the issue of internalizing social costs

should be carefully considered by companies. Two senior practicing CAs suggested that after

carefully determining and valuing social costs, these should be adequately shown in the

books of accounts. Companies should also take some steps to mitigate adverse impact of its

activities on the society and to compensate society for its wrong actions. They should

recognize the fact that in future, they may have to pay for their wrong actions or inaction

towards environment. Hence, it is better to accept these costs at an early stage and take

voluntary steps to protect the environment.

7.4.8 ENVIRONMENTAL LIABILITIES

A liability is a present obligation of the enterprise arising from past events, the

settlement of which is expected to result in an outflow from the enterprise of resources

embodying economic benefits in future.9 similarly, environmental liabilities are obligations

relating to environmental costs. According to ISAR, “Environmental liabilities are

obligations relating to environmental costs that are- incurred by an enterprise and that meet

the criteria for recognition as a liability.” In the light of this definition, an environmental

liability has been defined in the study as an obligation relating to environmental costs that are

incurred by an enterprise and the settlement of which is expected to result in an outflow of

resources from the enterprise in future.

Recognition and measurement of environmental liabilities is certainly more

problematic because these liabilities deserve special attention. Generally, future obligations

are regarded as liabilities, when there is a legal obligation to remedy an existing situation. On

account of the inherent unforeseen ability of future legislation, technological changes and the

extent or nature of environmental clean-up required, long term environmental liabilities are

often difficult to identify and measure. In this sub-section,-an attempt has been made to

present opinions of the respondents on the recognition and measurement of environmental

liabilities.

1. Recognition of Environmental Liabilities

Almost all the CAs (95.1 percent) were of the view that environmental liabilities

should be recognised when there is an obligation on the part of the company to incur an

environmental cost. In their opinion, these days environmental risk is a significant part of

total investment risk. Hence, creditors and investors are interested in knowing significant

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environmental liabilities of the companies particularly of manufacturing concerns. Only five

CAs felt that environmental liabilities need not be recognised separately in the financial

statements. They were of the view that in many cases environmental liabilities are not certain

and therefore, at the most, they can be termed as provisions.

About seven-tenths of the responding executives also favored separate recognition of

environmental liabilities in the financial statements. They were of the view that inclusion of

these liabilities in the financial- statements will give full information to the stakeholders

about a company’s financial position. This information T is very useful for potential

stakeholders or creditors to know about credit worthiness of the company and risks involved

in their investments.

2. Constructive Obligation

An obligation may be a legal obligation or constructive obligation. Constructive

obligation arises when a company is expected to incur a cost because public expects it or it is

standard industrial practice or management has declared it in its policy statement. Here

enterprise does not have any legal obligation, but only constructive obligation to incur a cost.

The respondents were asked whether a company should recognise an environmental liability

even when it has only a constructive obligation to incur the cost. They were also requested to

specify reasons for their answer.

More than three-fourths of the CAs were in favor of recognising constructive

obligations as environmental liabilities. They advanced many reasons for their viewpoint like

‘it is a part of social responsibility of business’, ‘required in broader social interest’ and

‘required to avoid future penalty’. They were of the view that once a commitment is made by

management, it should be fulfilled. Even when management fails to meet it in future, this fact

should be disclosed in footnotes to the financial statements together with reasons why this

enterprise’s management is unable to meet the commitment. Those who were against

recognition of constructive obligation as a liability, felt that social obligations need not be

recognised as liabilities in the financial statements. Moreover, in the absence of any

accounting standard or guideline, it is also difficult to measure these obligations. Their

viewpoints on the issue have been summarized in table 7.4.10.

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Table-7.4.10 Recognition of Constructive Obligation CAs’ Views

Reasons Number of

CAs

A. For recognizing

(a) Part of social responsibility 15

(b) Required in broader social interest 7

(c) Beneficial for the company 5

(d) Any other 12

B. For not recognizing

(a) No accounting standard requires it 5

(b) No need to recognize social obligation in financial statement 7

(c) Any Other 6

About three-fourths of the executives were also in favor of recognition of constructive

obligation as a liability. They gave many reasons for their viewpoint like it is a ‘part of

company’s social responsibility`, shows ‘management’s commitment towards environmental

issues’ or ‘it is a kind of contractual or moral liability’. However, most of them felt that these

obligations should be disclosed in the financial statements only when they can be measured

and are material. Otherwise, qualitative disclosures in the footnotes or Director’s Report are

sufficient. Their viewpoints have been summarized in table 7.4.11.

3. Difficulty in Estimating Environmental Liability

Sometimes, it is difficult to estimate the amount of an environmental liability. The

respondents were asked whether, in such a case, the liability should not be recognised or a

reasonable estimate of it should be provided, Majority of the CAs and the executives were of

the view that in such a case, a reasonable estimate of the liability should be provided in the

financial statements. However, the liability should be shown in the footnotes only, instead of

including it in the main body of the financial statements. Only a few respondents felt that in

these circumstances the liability should not be recognised in the books of accounts mainly

because it is not only difficult but also subjective to provide such an estimate. In rare

circumstances, it may not be possible for a company to estimate the environmental liabilities.

In such a case, the respondents generally felt that the company can disclose in the financial

statements the fact that no estimate has been made, together with reasons for not disclosing

the same.

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Table-7.4.11 Recognition of Constructive Obligation : Executives’ opinions

Reasons for Recognizing Number of

Responses

• Part of company’s social responsibility 12

• Shows management’s commitment towards environment 8

• Moral Liability 13

Reasons against Recognizing

• Difficulty in measurement 2

• Only legal liabilities to be recognized 4

• May not be enforced in future 2

4. Measurement of Long-term Environmental Liabilities

For measurement of long term environmental liabilities, ISAR expresses a preference

for using present value of the estimated future expenditures that will be needed, based on the

current cost of performing the required activities and existing legal and other requirements.

Measuring the liability at full ‘current cost’ amount is also considered acceptable by ISAR.

Majority of the CAs (60.4 percent) were in favor of using ‘discounted present value of

estimated future expenditure’ for measuring environmental liabilities. 24 CAs favored use of

estimated cost of performing the required activities in the current period. They feel that it is

difficult to find present value of future expenses and therefore, current cost method is the

best. About 45 percent of the executives preferred ‘present value method’ for measuring these

liabilities. However, about ,1/5 of them favored use of ‘current cost method’ as it is difficult

to use the previous method.

7.5 ENVIRONMENTAL REPORTING

Environmental reporting means incorporation of environmental issues into, the annual

reports or other statements prepared by corporate entities. It covers the preparation and

presentation of information by the management on the environmental activities and

performance of a company, for the use of various stakeholders. In the study, environmental

reporting has been taken as the disclosure of environment-related information by a company

regarding environmental risks, impacts, policies, strategies, targets, costs and liabilities to

those who have an interest in such information. This information may be reported through the

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annual report; a- stand-alone corporate environmental report (CER); an environmental

statement or some other medium like, video, Internet or staff newsletter.

As mentioned earlier, companies all over the world, are under increasing pressure

from the green lobby and regulatory authorities to disclose more environmental information.

Recent surveys have shown that a large number of companies (particularly multinational

corporations) have already started reporting on the environmental issues. As various

stakeholders (including investors, creditors and government) demand greater disclosure of a

company’s environmental impacts and resulting liabilities, companies will have to take care

of this aspect of disclosure more seriously. This Section presents environmental disclosure

practices of large manufacturing companies in India as reported by their chief executives. The

opinions of the respondents on various issues relating to environmental reporting have also

been given here. The Section is further divided into four sub-sections. Sub-section covers

general issues relating to environmental information disclosure by companies. Sub-section 2

obtains opinions of the accountants on the appropriate place where this information should be

disclosed and type of environmental information to be disclosed. An attempt has also been

made to examine practices of the companies regarding environmental disclosures. In sub-

section 3 qualitative characteristics that are needed to make environmental information useful

for the interested stakeholders have been discussed. `Finally, Sub-section 4 lists potential

users of these reports.

7.5.1 GENERAL ISSUES

As observed before, though environmental concerns have been heightened in recent

years, very few countries have specific financial reporting requirements on environmental

disclosures. In the absence of any standard or legal requirements on the issue, many

companies do not report on environmental matters. Even those· who report on the issue do

not follow a particular form and thus, there is no consistency in this reporting. This sub-

section presents opinions of the CAs and the executives on some general issues relating to

environmental reporting.

1. Uses of Environmental Information

These days, most of the big companies develop internal reporting system to capture

the cost effects associated with the adoption of environmental friendly business; practices and

also the resulting benefits. Companies can generate environmental performance reports for

internal decision-making. Moreover, the external environmental reporting can be used to

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convey the relevant information on environment to a wider audience. In this part, the relevant

uses of environmental information have been analysed.

A large majority of the CAs were of the view that environmental information should

be used for both the purposes. They felt that this information is required by management in

making various business decisions (e.g., capital budgeting decisions and estimation of cost of

production). Use of this information by management will make them conscious about

environmental concerns. It will not only help a company in complying with environmental

laws, but at the same time, will encourage voluntary reporting also. For supporting external

reporting of environmental information the respondents again gave various reasons like ‘it is

a part of good corporate governance practice’; ‘this information is required by external

stakeholders for decision-making; ‘required for global business’ and ‘will make accounts

transparent`. Only five CAs felt that information should be used for internal decision-making

only mainly because external stakeholders are not interested in these figures. On the other

hand, eight CAs argued that external reporting of this information is more important and

should be given more emphasis.

Regarding actual practices, majority of the companies (75 percent) used

environmental information produced by them for both the purposes, i.e., internal decision-

making as well as external reporting purposes. 22 executives stated that their companies used

most of this information mainly for managerial decision-making purposes and only legally

required information was reported to outsiders.

2. Non—disclosure of Negative

Environmental Information: It is a common belief that companies operating in

environmentally sensitive areas do not disclose environmental information voluntarily,

particularly bad news, because the disclosure may jeopardize confidentiality in the sensitive

areas and thereby, may adversely, affect competitive position of the company. About 64

percent of the CAs agreed with this belief. They felt that fear of action from regulatory

authorities and of misuse of information by competitors compel companies not to disclose

information on their environmental impacts (particularly negative information). 34 CAs did

not consider it to be the most pertinent reason for non-disclosure of environmental

information. They were of the view that there are other important reasons also like ‘non-

sensitivity towards environmental issues’, ‘lack of top-management commitment’, ‘voluntary

nature of environmental reporting’ and ‘absence of accounting guidelines and standards on

the issue.’

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About three-fifths of the executives felt that the fear of negative publicity is one of the

main reasons for non-disclosure of negative environmental information. They were of the

opinion that disclosure of bad news (like, oil spills, gas leak, adverse impact on environment)

may lead to governmental action and criticism from the public and competitors can take

advantage of this. It affects confidentiality in the sensitive areas and may affect competitive

position of the company. About 36 percent of the executives were of the view that though this

may be one of the reasons for non-disclosure in highly polluting industries; in general,

companies do not disclose environmental information because of various other reasons like

‘it is not mandatory’, ‘general public has no interest in environmental figures’ or ‘lack of

accounting standards or guidelines’.

3. Making Environmental Information Disclosure Mandatory

Disclosure of environmental information (except on energy conservation) is not

mandatory in India. A review of the existing studies on environmental disclosure practices of

Indian companies reveals that in the absence of any accounting standard or legal compulsion,

both quality and quantity of environmental reporting has been quite limited. The executives

in the study also informed that their companies didn’t prepare environmental accounts mainly

because it was not required by law. The respondents were asked whether disclosure of

environmental information should be made mandatory in India.

About 90 percent of the CAs and 76 percent of the executives were of the opinion that

environmental information disclosure should be made mandatory in India. Most of them

believed that companies in India arc not self-disciplined and very rarely do- things

voluntarily.. It will make companies environmentally conscious and will encourage eco-

efficiency. lf a company has to report its environmental activities or performance to the

relevant stakeholders under legal compulsion, the company will definitely try to perform

better.

However about 24 percent of the executives were against making environmental

reporting mandatory. They felt that as long as a company is taking good care of environment,

reporting or non-reporting on it does not matter. Making environmental information

disclosure compulsory will unnecessarily lengthen the annual reports, will increase

expenditure and lead to wastage of time, cost and energy. Therefore, only voluntary

disclosures should be there. Two senior managers suggested, In the initial years reporting of

some important environmental information items should be made mandatory, that too only

for most polluting industries. For other companies, it should only be recommendatory. Later

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on, in phases, some more items can be selected for mandatory environmental reporting.

Moreover, some more companies can be asked to report compulsorily on environment”.

7.5.2 PLACE AND TYPE OF ENVIRONMENTAL DISCLOSURES

As noted above, majority of the respondents think that a company should disclose

information on its environmental activities and performance. This sub-section presents their

views on the appropriate place where environmental information should be disclosed and

type of environmental information to be disclosed.

1. Place of Disclosure:

Environmental information can be disclosed in the annual reports or by some other

medium like environmental statements or web-sites. However, annual report is generally

considered to be the most appropriate place for reporting this information because, firstly, it

has wider audience and secondly, the information given in annual report is verified by

auditors10. In the annual report also, this information can be disclosed at various places like in

the main body of financial statements, footnotes or in Directors’ Report. About 49 percent

of the CAs were in favour of disclosure of environmental information in Director’s Report or

its annexure. Almost same proportion of the CAs supported disclosure of this information in

‘separate environmental section’ in the annual report. Only 13 CAs felt that this information

should be communicated in the main body of financial statements, i.e., Profit .& Loss

Account or Balance Sheet. These CAs were asked about advantages of disclosing

environmental information at this place. They gave two main reasons for their views., Firstly,

if the concept of environmental accounting is to be followed seriously, the information on

environmental costs, benefits, assets and liabilities should be disclosed in Profit & Loss

Account and Balance Sheet. In this way, the matter of environmental accounting will receive

due importance. Secondly, disclosure of this information in the financial statements helps in

examining the impact of environmental performance on trading results and financial position

of the company. This facilitates decision-making by various stakeholders.

Those CAs who were of the opinion that environmental information should not be

disclosed in the financial statements also cited various reasons for their viewpoint, Most of

them felt that separate disclosure of this information either in the annual report or stand—

alone environmental reports will be more beneficial for the interested stakeholders. It will

also highlight importance of this information. Other reasons advanced by some of them were,

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‘difficulty in measurement’, ‘lack of accounting standards or guidelines’ and ‘will make

annual report bulky’. Table-7.5.1 summarizes views of the CAs on the issue.

Table-7.5.1

Disclosure of Environmental Information in the Main Financial Statements : CAs views

Reasons Number of CAs

A. For Disclosing Increases seriousness in the issue 3 Helps in checking its impact on trading results and financial position 8 Will be verified by auditors 3

B. For not Disclosing Difficulty in measurement 7 Lack of accounting standards 5 Will make annual report bulky 17 Not required by law 4 Separate disclosure more beneficial 30 Will lead to confusion 2 Any Other 13

Table-7.5.2 presents practices of the companies regarding place of environmental

information disclosure.

The table shows that about 92 percent of the companies disclosed environmental

information in the Director’s Report. The executives belonging to 20 companies informed

that their companies prepared separate environmental statements also. Most of these

companies were public sector corporations or large private sector companies operating in

polluting industries.11 Main body of the financial statements, footnotes or annexure were not

found to be popular modes of disclosing details on environmental issues. Two companies

made these disclosures at other places also like through Internet and press releases.

As evident from the Table that only one company disclosed information on

environmental issues in the main body of the financial statements. The executives were asked

why their companies did not disclose information in the main body of financial statements.

They gave various reasons for this practice like ‘disclosure in the financial statements does

not affect usefulness of information for decision-makers’, ‘will have no effect on

conventional accounting format’ and ‘not recommended by professional bodies’. Some other

reasons given by them were, ‘will make financial statements bulky’, ‘may distort purpose of

financial statements’, ‘may create confusion’, ‘society does not require it’ and ‘will lead to

window dressing’.

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Table-7.5.2 Place of Environmental Information Disclosure: Companies’ Practices

Number

Place Companies Disclosing

Main body of the financial statement 1 Footnotes of the financial statements 2 Director’s report 92 Separate annexure to the financial statements 3 Separate financial statements 20

2. Type of Information Disclosed

A company can disclose quantitative information on environment, e.g., information

on environmental costs, benefits, assets or liabilities. Similarly, qualitative details on

environmental policies and practices of` a company can be reported by management. This

part seeks to record opinions of the CAs on the type of information, which a company should

disclose. The actual practices of the companies regarding this have also been examined.

Table 7.5.3 presents comparative analysis of the responses.

The table depicts that a large majority of the CAs (91.1 percent) recommended

disclosure of qualitative as well as quantitative information on environmental issues by a

company. Only a negligible number favored disclosure of only qualitative or only

quantitative information mainly to save time and resources of the company.

Table-7.5.3

Type of Environmental Information Disclosed Number

Particulars CA’s Opinions Actual Practices Qualitative only 1 52 Quantitative only 5 2 Both 92 38 N.A. 3 9 Total 101 101 Note : N.A. Not Answered

(Percent)

Particulars CA’s Opinions Actual Practices Qualitative only (1.0) (51.5) Quantitative only (5.0) (2.0) Both (91.1) (37.6) N.A. (3.0) (9.0) Total (100) (100) Note : N.A. Not Answered

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However, more than one-half of the executives informed that their companies

disclosed only qualitative details about environmental policies, systems and practices of the

company. The annual reports of these companies mainly included information on ‘energy

conservation’ as required to be disclosed under provisions of the Indian Companies Act. This

shows existence of a significant environmental reporting expectation gap in India. Though

users want information on both qualitative and quantitative aspects, most of the companies

give only descriptive information on the issue. Only about 38 percent of the responding

executives claimed that their companies disclosed quantitative as well as qualitative

information.

7.5.3 QUALITATIVE CHARACTERISTICS OF ENVIRONMENTAL

INFORMATION

Qualitative characteristics are very important for the overall credibility of reporting12.

Reporting on the nature of environmental impacts means that in order to make the processes

of measurement and reporting feasible and credible, certain underlying assumptions may

need to be made about either the reporting enterprise or the data being reported on13 Most of

the underlying assumptions and qualitative characteristics of financial reporting are equally

applicable to environmental reporting also. For making environmental report useful for

external stakeholders, it must also possess certain characteristics like it should be relevant,

reliable and understandable. There is a need to present data in as uniform manner as possible,

if it is to be of any significant use to external shareholders, However, application of some

characteristics is a bit complex in environmental reporting. For example, the application of

materiality concept in case of environmental reporting is heavily dependent on the carrying

capacity of the receiving environment (such as availability of landfill capacity or background

air pollution levels). Moreover, environmental reports may contain some information, which

cannot be objectively determined or physically quantified, e.g., environmental impact of

company’s- activities and long-term sustainability. Accordingly, some qualitative

characteristics may have to be modified. The standard setters should make adequate

provisions accordingly while setting conceptual framework for environmental reporting.

The respondents were asked about their opinions on the qualitative characteristics that

must be possessed by the reported environmental information to make it more beneficial for

the users. ‘Useful in decision-making’ was considered as the most important characteristics

of environmental information by about 35 percent of the CAs. According to them, there is no

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use of giving any information in the annual reports or by some other medium, unless it is

useful to the stakeholders in making various financial or other decisions. Therefore, only

material and significant information that facilitate decision-making should be supplied by a

company. Objectivity was another characteristic considered important by them. Till date, in

the absence of any accounting standard or guideline on the issue, the environmental

information given in the annual report by companies has been generally subjective (e.g., only

positive or good information is generally given). In order to make environmental information

more useful for the interested external stakeholders, it should be objective. Other

characteristics considered as the most important by some of them were relevance, reliability,

understandability and completeness. Some CAs felt that all these characteristics are equally

important as there is an overlapping in some of these characteristics. For example, in order to

be useful in decision-making, information is to be relevant, reliable, objective and complete.

Majority of the executives (55.4 percent) were also of the view that environmental

information supplied by a company should be useful in decision-making. Most of them felt

that in order to make this information valuable for the stakeholders, it is essential that only

relevant and objective information is provided to them. Other important characteristics most

preferred by about 45 percent of the executives were understandability, consistency,

completeness and reliability. Again some managers were of the view that all these

characteristics are important and must be taken care of while preparing environmental

reports.

It is to be noted that least important characteristics according to the qualified

respondents were timeliness and comparability. They were of the opinion that sometimes it

may not be possible for a company to give timely details on environmental issues, as it is

difficult to measure its impact in a particular time frame. Moreover, in some circumstances, it

may become relevant later on due to changes in legislation or otherwise. Similarly,

environmental information given by various companies may vary due to differences in their

product, process, technology, design or legal requirements for various industries. Thus,

certain features of environmental disclosures made by them cannot be compared.

Cost-effectiveness of Environmental Information

A company before undertaking any activity generally conducts cost-benefit analysis.

Most often, this is one of the bases for making many important decisions. The cost—benefit

principle says that cost of applying something should not exceed its benefit. In financial

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reporting also one of the pervasive constraints is that the benefit to be gained from providing

information should be greater than the cost of providing it14.

Majority of the CAs (80.2 percent) agreed that the benefits of providing

environmental information should be more than the cost involved in it. In their opinion, a

formal cost-benefit analysis will help a company in justifying its decision relating to

provision of environmental information to stakeholders. Some of them clarified, “It does not

mean that to save cost, no or very little information should be given to the users. A certain

minimum level of information absolutely essential in decision-making should be provided”.

20 CAs were of the opinion that in providing environmental information, this kind of cost-

benefit analysis should not be done. They gave two main reasons for their viewpoint. Firstly,

disclosure of environmental information is a part of social responsibility of a company and in

these matters, cost factor should not be considered. Secondly, in case of environmental

issues, though cost of doing something is generally tangible, most of the times, the benefits

are intangible (e.g., enhanced image due to environmental reporting). Moreover, cost of not

taking an action (e.g., loss of goodwill due to non-disclosure of environmental information) is

also generally difficult to measure. It is, therefore, not feasible to conduct this kind of

analysis.

About seven-tenths of the executives informed that the benefits of environmental

information to the potential users are generally greater than the cost of providing such

information. They told that these days most of the companies prepare environmental

statements for internal decision-making purposes. Since this information is already available

in the organization, its reporting to the external stakeholders does not involve much cost. On

the other hand, various stakeholders (including creditors, government and investors) can take

benefit of this information in making relevant financial or other decisions. The company is

also benefited because of enhanced image, increased sales and reduced pressures from

government.

7.5.4 USERS OF ENVIRONMENTAL INFORMATION

The IASC conceptual framework differentiates between seven user groups, but is

based upon a primary assumption that the needs of financial investors are pre-eminent, and

that if their needs are met, then the needs of most other users should be at least partially met.

There are various stakeholders like investors, creditors, government and society at large who

are interested in environmental disclosure made by a company. United Nations working

Group of Experts, ISAR identified various users of environmental information like

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shareholders/prospective owners, internal line managers, local/regulatory authorities or

environmental organizations. These users generally have varying information needs. A

company has to identify its relevant users and accordingly decide about the type and nature of

environmental information to be disclosed. This also affects the mode by which this

information is to be reported and the place where it is to be disclosed (e.g., generally,

information to government is given in statutory forms and to shareholders in the annual

reports). In this part, the CAs and the executives were asked to rank the given users of

environmental information in order of importance.

‘Society at large’ was considered as the most relevant user of environmental

information by about 58 percent of the CAs. ‘Government’ and ‘Environmental

Organizations/NGOs’ were two other users considered important by them. These CAs were

of the opinion that environmental information is mainly useful for the society at large. All the

constituents of society need the details on environmental performance of an organization

because all of us are a part of environment and in one way or the other, are affected by it.

Thus, this information should be directed to a wider audience. In addition, specific purpose

statements can be prepared to meet specific needs of some segments of the society. It is to be

noted that a significant percentage of the .CAs (more than three-fifth) did not consider

suppliers, competitors, customers and journalists to be the relevant users of this information

(they gave zero ranks to these users).

About three-fourths of the executives considered ‘government’ as the most important

user of environmental information. One of the manager informed, “Generally environmental

information is published to demonstrate to the regulatory authorities that the company is

complying with environmental laws and also taking voluntary steps to protect the

environment. Most of the times, company is legally required to submit these details to the

government. Environmental reporting helps in releasing pressures from regulatory

authorities. Hence, government/regulatory authorities are the most important users of

environmental information”. Society at large and environmental organizations (NGOs) were

two more users considered important (given one of the first three ranks) by more than 65

percent of the respondents. According to them, environmental reporting helps to build the

trust of the local community. It makes it easier for a company to operate and expand.

Furthermore, in recent years, non-governmental organizations have become quite active

towards environmental problems and many a times their efforts lead to judicial action. The

least important users according to the executives were competitors. suppliers and customers.

Some companies informed about other users also like foreign institutional investors.

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7.6 ENVIRONMENTAL AUDIT

The term environmental audit has been explained by various authors and professional

-bodies differently. Broadly, it involves audit of environmental management system,

environmental activities, and environmental performance of an organization. But for this

study, environmental audit has only been taken as audit of information given in the annual

reports or environmental statements prepared by a company. Thus, the scope of

environmental audit is restricted to only verification of environmental information reported

by a concern. It does not, therefore, covers various technical and other aspects involved in

environmental audit like energy audit, procedure audit, emission audit or environmental

performance audit. Environmental audit has been defined as a systematic process of

objectively obtaining and evaluating the evidence relating to performance of an organization

as reflected in the environmental statements. Thus, environmental audit attempts to examine

and report verifiable, quantitative and qualitative information in the relevant areas.

Some existing research works on environmental reporting have highlighted the growing need

for verification of environmental reports produced by a concern15. This part seeks to analyze

views of the responding accountants on the need and significance of environmental audit. In

addition an attempt has been made to examine practices of the companies relating to

preparation of environmental statements and their verification.

7.6.1 NEED FOR AUDIT OF ENVIRONMENTAL INFORMATION

The views of the CAs on the need for audit of environmental statements were

obtained in the study. A large majority of the CAs (91.2 percent) were of the opinion that

environmental reports should be audited. They felt that in order to make environmental

information given by a company objective, reliable and useful in decision-making, it should

be verified by an independent auditor.

The CAs who advocated verification of environmental report was further asked to

rank given benefits of environmental audit in order of importance. Their responses are

presented in table 7.6.1. It shows that about 41 percent of the CAs considered ‘increases

credibility of information provided’ as the most important benefit of environmental audit.

About three-fourths of them gave one of the first three ranks to this benefit.

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Table-7.6.1 Preparation and Audit of Environmental Statements: Actual Practices

Reasons Ranks

0 1 2 3 4 5 6

a) Increases creditability of information provided 4 41 16 11 10 6 2

b) Guarantees validity and accuracy of environmental data and reports 8 19 25 12 15 8 2

c) Ensures compliance with environmental laws 4 33 21 22 4 4 2

d) Checks adherence with pre-determined policies of management 16 10 8 15 15 18 8

e) Assists management in decision-making 17 10 4 9 23 20 7

f) Helps in responding to pressures from regulatory authorities and NGOs 11 10 5 7 5 15 37

g) Any Other - - - - - - -

Reasons Ranks

0 1 2 3 4 5 6

a) Increases creditability of information provided (4.4) (45.6) (17.8) (12.2) (11.1) (6.7) (2.2)

b) Guarantees validity and accuracy of

environmental data and reports

(8.9) (21.1) (27.8) (13.3) (16.7) (8.9) (2.2)

c) Ensures compliance with environmental laws (4.4) (36.7) (23.3) (24.4) (4.4) (4.4) (2.2)

d) Checks adherence with pre-determined policies of

management

(17.8) (11.1) (8.9) (16.7) (16.7) (20) (8.9)

e) Assists management in decision-making (18.9) (11.1) (4.4) (10) (25.6) (22.2) (7.8)

f) Helps in responding to pressures from regulatory

authorities and NGOs

(12.2) (11.1) (5.6) (7.8) (5.6) (16.7) (41.1)

g) Any Other - - - - - - -

Hence, there is no need to audit it. Three of them gave non-mandatory nature of

environmental audit as the main reason for not recommending this audit. They suggested that

first of all, all the companies should be encouraged to report on environment voluntarily.

Then after some years, reporting of externally audited environmental information can be

made mandatory. Other reasons given by some of them were ‘time consuming’, ‘expensive’,

and ‘no verification standards’.

7.6.2 PREPARATION AND AUDIT OF ENVIRONMENTAL

STATEMENTS BY SAMPLE COMPANIES

Table 7.6.2 presents practices of the sample companies regarding preparation and

audit of environmental statements.

The table depicts that about seven-tenths of the responding companies prepared

environmental statements. These companies were further asked whether preparation of

environmental statements was statutorily required in their industries. The table shows that in

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large majority of these companies (92.8 percent), preparation of environmental statements

was a statutory requirement. 56.5 percent of these companies also prepared environmental

statements voluntarily. Generally a high proportion of public sector companies prepared these

statements. Their commitment towards betterment of society and open disclosure policies

might be the reasons for that.

Table 7.6.2 Preparation and Audit of Environmental Statements: Actual Practices

Particulars Yes No N.A. Total (100 percent)

1) Preparation of Environmental Statements 70 27 4 101

2) Preparation of mandatory environmental statements

64 5 - 69*

3) Preparation of voluntary environmental statements 39 30 - 69*

4) Audit of environmental statements 48 21 - 69*

*Note : These questions were applicable to 70 executives but answered by 69 executives

only.

Particulars Yes No N.A. Total (100

percent) 1) Preparation of Environmental Statements (69.3) (26.7) (4) 101

2) Preparation of mandatory environmental statements

(92.8) (7.2) - 69*

3) Preparation of voluntary environmental statements

(56.5) (43.5) - 69*

4) Audit of environmental statements (69.6) (30.4) - 69*

It was further noted that about seven-tenths of the companies produced audited

environmental statements. The executives from these companies were requested to rank the

given benefits of auditing these statements in order of importance. Table 7.6.3 reveals that

‘ensures compliance with environmental laws’ was considered as the most important benefit

of this kind of environmental audit by about 73 percent of the executives. According to them,

verification ensures that the company is complying with these laws and if any default is there,

it comes to the knowledge of the management. About three-fifths of the managers felt that

environmental audit ‘increases-credibility of information provided’ to different stakeholders.

Some executives gave other benefits also like ‘it helps in self-appraisal’, ‘checking of

information before submission to authorities’ and ‘ensures that correct information is

supplied to authorities’.

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Table-7.6.3 Benefits of Environmental Audit: Executives’ Perception

Number

Reasons Ranks

0 1 2 3 4 5 a) Increases creditability of information provided 10 30 2 3 2 1 b) Guarantees validity and accuracy of environmental data and

reports 8 19 25 12 15 8

c) Ensures compliance with environmental laws 4 33 21 22 4 4 d) Checks adherence with pre-determined policies of

management 16 10 8 15 15 18

e) Assists management in decision-making 17 10 4 9 23 20 f) Helps in responding to pressures from regulatory authorities

and NGOs 11 10 5 7 5 15

g) Any Other - - - - - -

(Percent)

Reasons Ranks

0 1 2 3 4 5 h) Increases creditability of information

provided 20.8 62.5 4.2 6.3 4.2 1

2.1 i) Guarantees validity and accuracy of

environmental data and reports (8.9) (21.1) (27.8) (13.3) (16.7) (8.9)

j) Ensures compliance with environmental laws

(4.4) (36.7) (23.3) (24.4) (4.4) (4.4)

k) Checks adherence with pre-determined policies of management

(17.8) (11.1) (8.9) (16.7) (16.7) (20)

l) Assists management in decision-making

(18.9) (11.1) (4.4) (10) (25.6) (22.2)

m) Helps in responding to pressures from regulatory authorities and NGOs

(12.2) (11.1) (5.6) (7.8) (5.6) (16.7)

n) Any Other - - - - - -

About 30 percent of the companies produced unaudited environmental statements.

These companies were enquired about the problems in verification of these reports. Table

7.6.4 gives analysis of the responses. A large majority of the executives (93.8 percent of the

companies which did not produce verified environmental reports) stated that their companies

did not produce verified statements because it was not required by law. Some of them were of

the opinion that environmental audit should be made mandatory in India (particularly in

environmentally sensitive industries). ‘No specific auditing standards’ was another problem

considered important by the companies. These executives felt that in the absence of specific

standards on the issue, the verification of these statements is meaningless. It will not add

much incremental value to these statements

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Table-7.6.4 Problems in Environmental Audit: Executives’ Views

Number

Reasons Ranks

0 1 2 3 4 5 a) Expensive 24 - 1 - 7 - b) Time Consuming 24 - - 7 - 1 c) Not Mandatory 1 30 - 1 - - d) No specific standards 19 3 9 - 1 - e) Any Other 30 2 - - - -

(Percent)

Reasons Ranks

0 1 2 3 4 5 a) Expensive (75) - (3.1) - (21.9) -

b) Time Consuming (75) - - (21.9) - (3.1) c) Not Mandatory (3.1) (93.8) - (3.1) - - d) No specific standards (59.4) (9.4) (28.1) - (3.1) - e) Any Other (93.8) (6.3) - - - -

7.6.3 ENVIRONMENTAL AUDITORS

The CAs who were in favour of providing verified environmental information to the

interested stakeholders were further asked to render their opinions on the number, status and

qualifications of the environmental auditors. 93.7 percent of the CAs preferred appointment

of a team for this task, They were of the opinion that environmental audit involves a lot of

things and an individual may not handle all these aspects. Only six CAs were in favor of

giving this task to an individual. Some of them argued, “An individual can easily handle this

task because till date, Indian companies provide only limited information on environmental

issues. Hence, appointment of a team for this purpose will lead to wastage of energy, time

and cost”. Some of these CAs were of the opinion that an external auditor should be given

this task as it will increase credibility, validity and objectivity of environmental information

provided by a concern.

The CAs who favored appointment of a ‘team’ of environmental auditors were further

asked about the preferred qualifications of the persons in this team. Majority of the CAs (75.8

percent) were in favor of appointing ‘qualified environmental auditors’ for auditing

environmental reports. They were of the view that environmental audit, being a new area,

requires separate education and training and only qualified environmental auditors can

perform this task efficiently. More than one-half of them supported appointment of `chartered

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accountants’ for verifying the financial details given in the report. About 37 percent wanted

‘engineers’ in the team for handling technical matters.

Analysis of Actual Practices

An analysis of actual practices shows that a large majority of concerns (95.2 percent)

appointed a team to do “environmental audit. Environment is a multidisciplinary subject and

an individual cannot handle the task of environmental audit effectively. Hence, a team was

given this task.

The executives were further asked about the status of the environmental auditor

(internal vs. external) appointed by them. Most of these companies appointed external

persons as environmental auditors. These companies found it necessary to ensure.-

independence and objectivity in this task. One of the executives informed, “Environmental

risk is an important part of credit risk and therefore, creditors want independently verified

environmental statements from the companies to get authentic information about their

environmental performance, potential hazards and future environmental liabilities.” .

However, some companies gave this task to internal auditors. They gave two main reasons

for this practice. Firstly, environmental audit is not a statutory audit and therefore, it is not

necessary to appoint external persons for this. Secondly, internal auditors are available within

the organization. They know about company`s policies and procedures. Hence, it is better to

appoint them as environmental auditor. The executives were also asked to tell about

composition of environmental audit team. 81.7. percent of the companies appointed qualified

environmental auditor to do this work. In some companies ‘engineers’ and ‘chartered

accountants’ were employed to handle specific technical and accounting aspects respectively.

Some executives felt that the ‘chartered –accountants’ are able to provide input with regard to

the verification of financial data, cost-benefit analysis, compliance status and implementation

of` EMS.

7.7 SUMMARY AND CONCLUSIONS

This Section presents summary and conclusion of the primary data analysis. The main

objective of this Chapter was to examine existence of an environmental accounting and

reporting (EAR) expectation gap in India. For this purpose, opinions of the selected

Chartered accountants were obtained regarding their expectations about corporate

environmental accounting and reporting in India in addition, the actual EAR ` practices of the

selected large manufacturing companies operating in India were analysed with the help of

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primary data to examine whether they fulfill expectations of the users of environmental

information.

The qualified accountants and the senior executives in large manufacturing companies

felt that environment is a big challenge for business these days. The CAs, in general, were of

the opinion that companies should establish EMS to meet these challenges. Establishment of

a good EMS helps in maintaining clean and green environment around the factories,

controlling pollution emission and thereby meeting legal standards in this area} An

examination of actual practices showed that a large majority of the companies (89.11 percent)

already had EMS in their organizations, while some companies were planning to introduce it

in near future, A large majority of the respondents were of the opinion that the current

financial accounting framework is not comprehensive enough to deal with environmental

problems. Most of them were in favor of development of a separate conceptual framework

and a specific comprehensive standard for environmental accounting to effectively deal with

specific issues involved in it.

Almost all the CAs felt that a company should use environmental accounting system

mainly because it helps in complying with environmental laws. The other two benefits

regarded important by them were, “helps management in decision-making’ and ‘provides

better estimates of cost of producing a product’. But it was found that a substantially high

proportion of the companies (93.1 percent) did not prepare environment related accounts for

external reporting purposes. Thus, a significant expectation gap exists in this area. The

managers gave non-mandatory nature of environmental accounting as a justification for not

preparing these accounts. It seems that the companies in India are reluctant to take initiatives

in this regard. Their main aim seems to be furnishing only that information which is legally

required or which can influence the decisions of their stakeholders about them. The

executives also mentioned ‘no accounting standard and guideline’ as the reason for not

preparing these accounts. It was interesting to note that more than one-half of the companies

had practice of generating and using internal environmental statements for managerial

decision-making. It seems that companies have started environmental accounting in

providing inputs for successful implementation of EMS. The study found popularity of the

concept of environmental accounting in India only at the management accounting level.

The respondents were of the opinion that environmental cost information generated by

environmental accounting is useful in ‘designing various processes using environmental

friendly technologies’. They also found this information useful in appraisal of investment for

environmental risks and environmental impact assessment. For treatment of environmental

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costs and benefits in the financial statements both CAs and the executives recommended use

of same financial accounting principles with some modifications according to the nature and

extent of environmental costs.

The CAs felt that a company should try to determine external adverse impacts of its

activities (social costs). They recommended consideration of these costs in strategic decision-

making. About 88 percent of` them were of the view that a company should also try to value

these social costs so that it can take necessary steps to reduce adverse impact of its activities

on environment. Regarding actual practices, though majority of the companies tried to

determine external adverse impact of their activities on environment (social costs), most of

them did not try to value these social costs. About 90 percent of the companies considered

these costs in making strategic business decisions like, in capital budgeting. A large majority

of the CAs and the responding executives were of the view that due to growing legal and

social pressures, most of these external costs will become internal in future (e.g., companies

will have to bear penalties or clean up pollution).

The respondents generally supported recognition of environmental liabilities in the

financial statements when there is an obligation (legal as well as constructive) on the part of a

company to incur an environmental cost, When there is difficulty in estimating an

environmental liability, a reasonable estimate of it should be provided. In rare circumstances,

when it is not possible for a company to estimate environmental liabilities, this fact along

with the reasons therefore, should be disclosed. For measurement of long-term environmental

liabilities, most of the respondents preferred use of ‘discounted present value of expected

future costs using risk free rate’.

The CAs, in general, recommended that a company should use environmental

information for both internal decision-making and external reporting. They also felt that

companies must disclose qualitative as well as quantitative information on these issues. Most

of them preferred disclosure of this information in separate environmental statements to

‘highlight its importance’ and to ‘avoid any confusion’. Furthermore, they also approved

disclosure of qualitative information in the ‘Director’s Report’.

An examination of the actual practices revealed that about one-half of the companies

disclosed only qualitative information on environment in the annual reports. The companies

mainly used the Director’s Report to supply environmental information to external

stakeholders. [Roy (2000) also observed that the common practice followed by the Indian

companies in both public and private sector over the years regarding environmental

disclosure was to offer descriptive information and itemize the same in the Director’s Report.

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Only a few companies disclosed information through notes, schedules and a separate social

account. Jaffer et. al (2002) also found most of the environmental information in the Review

of Operations section and in Chairman’s statements. As compared to this, Jones (2000) in a

study of 88 European companies for environmental disclosures found that out of 12 sections

identified in the annual reports, three-fourths of the companies provided this information in

the ‘environmental section’] The study found existence of a significant environmental

reporting expectation gap in India. Some companies (about one-fifth) also prepared separate

environmental statements to communicate this information. Some of the executives were of

the view that disclosing these details in the main body of financial statements would serve a

better purpose. However, more than one-half were against this as it may ‘make financial

statements bulky’, ‘create confusion’ and ‘will not facilitate decision—making by

stakeholders’.

‘Usefulness in decision-making’ was considered as the most important characteristic

of good environmental statements by majority of the CAs and the executives. For this, the

information should be relevant and objective. Timeliness and comparability were considered

less important by the executives. Majority of the respondents were of the view that benefits of

environmental information to the potential users are greater than the cost of providing it.

The environmental statements should be prepared keeping in mind users’ needs. ‘Society at

large’ was considered to be the most relevant user of environmental information by the CAs.

‘Government’, ‘environmental organizations’ and ‘owners’ were other relevant users,

according to them. However, the executives found ‘government’ to be the most important

user of this information because these statements were mainly prepared to comply with the

legal requirements. It helped in reducing pressures from regulatory authorities. The least

important users according to the respondents were competitors, suppliers and customers.

A large majority of the CAs were in favor of mandatory disclosure of environmental

information. About three-fourths of the executives were also -of the same view. It seems that

compulsory environmental information disclosures will increase seriousness in the issue` and

will lead to overall increase in environmental reporting by Indian companies. The findings of

the study revealed that la large majority of the CAs favored verification of environmental

statements prepared by a company mainly to ‘increase credibility of information provided’ in

them. They felt that this audit would also help a company in complying. With environmental

laws. The responding CAs felt that a company should submit its environmental report to

independent scrutiny mainly to underpin the credibility of the environmental report. (As

compared to this, the research published in 1996 by the Global Environmental Management

225

Initiative (GEMI) and the Investor Responsibility Research Centre (IRRC) in Washington

DC found that the significant stakeholder groups through that verification added little, if

anything, to the credibility of the reports overall. The lack of standards for verification was

found to be the main drawback at the moment (GEMI 1996).

The CAs, in general, favored appointment of a team, mainly comprising of external

environmental auditors to do this task. They felt that ‘Chartered accountants', ‘engineers’ and

‘cost accountants’ might also form a part of this team to handle specific tasks.

A scrutiny of actual practices followed by the large Indian companies revealed that

while most of the companies prepared statutorily required environmental statements, only

about 39 percent prepared these statements voluntarily. About seven-tenths of these

companies got these statements verified by an auditor mainly to ensure compliance with

environmental laws and to increase credibility of the information provided in these reports.

The task of environmental information audit was generally given by the responding

companies to a team of auditors. Most of these companies appointed external environmental

auditors for this purpose; while some companies assigned specific tasks to engineers and

chartered accountants. However, about three-tenths of the companies produced unaudited

environmental statements mainly because verification of environmental reports was not

required by law. It is therefore, recommended that Environmental information audit (EIA)

should be made mandatory at least in major polluting industries. This can be extended to

other industries, after the audit systems in the polluting industries are well documented. ‘No

specific standard` on the issue was another problem considered significant by the companies.

It was felt by the respondents that to increase credibility and reliability of environmental

information supplied to various interested stakeholders, it should be verified by some

independent auditors as per accounting standards issued by the ICAI.

The findings of the study reveal that the respondents were convinced by the need for

having an EAR system in the large companies in India. No significant difference was found

between the views of users and the preparers on various issues raised in the study. Both the

CAs and the executives found usefulness of environmental information in strategic decision-

making. They felt that benefits of providing environmental information to the relevant users

are more than cost of providing this information. The CAs and the executives favoured

mandatory environmental reporting in India. But when actual EAR practices (as reported by

the executives) were analyzed, significant differences were found in expectations of the users

and actual practices of the companies. Though, a large majority of CAs felt that companies

must adopt environmental accounting system, only a negligible number of companies were

226

found to be preparing these accounts for external reporting purposes. The users preferred

separate environmental statements and Directors reports for disclosing qualitative as well as

quantitative information on environment. However, most of the companies had the practice of

disclosing only qualitative environmental information in the annual reports mainly through

the Director’s Report. Indian companies failed to provide adequate disclosures of their

environment activities and performance. The evidence is consistent with the existence of an

environmental accounting and reporting (EAR) expectation gap within India16.

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New century publication, New Delhi, India 2009. Pp no 90-175.

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